Prob20_12

Problem 20-12

Williams-Santana, Inc., is a manufacturer of high-tech industrial parts that was started in 2001 by two talented engineers with little business training. In 2013, the company was acquired by one of its major customers. As part of an internal audit, the following facts were discovered. The audit occurred during 2014 before any adjusting entries or closing entries were prepared.

For each situation (1) identify whether it represents an accounting change or error. If an accounting change, identify the type of change; (2)

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g g , y yp g ; ( )Prepare any journal entry necessary as a direct result of the change or error correction as well as any adjusting entry for 2013 related to the situation described; (3) Briefly describe any other steps that should be taken to appropriately report the situation.

Problem 20-12 (continued)

a. A five-year casualty insurance policy was purchased at the beginning of 2011 for $35,000. The full amount was debited to insurance expense at the time.

This is an accounting error that requires retrospective restatement.The amount that should be charged to expense every year is $7,000

($35,000 ÷ 5)2011: Expense O/S NI U/S R/E U/S by $28,000 ($35,000 - $7,000)2012: Expense U/S NI O/S by $7,000 R/E is now U/S by $21,000


Correcting Entry: Prepaid insurance (3 x $7,000) 21,000R/E 21,000

Adjusting Entry: Insurance expense 7,000Prepaid insurance 7,000

A prior period adjustment to retained earnings would be reported, along with a disclosure note describing the nature of the error and the impact of its correction on each year’s net income, income before extraordinary items, and EPS.


b. Effective January 1, 2013, the company changed the salvage value used in calculating depreciation for its office building. The building cost $600,000 on December 29, 2002, and has been depreciated on a straight-line basis assuming a useful life of 40 years and a salvage value of $100,000. Declining real estate values in the area indicate that the salvage value will be no more than $25,000.

This is a change in estimate that is handled prospectively.

Annual depreciation before the change = ($600,000 - $100,000) ÷ 40 = $12,500

2013 Book value = $600,000 – [(10 x $12,500)] = $475,000


New residual value = $25,000

Remaining life = 30 years (40 – 10)

New depreciation = ($475,000 - $25,000) ÷ 30 = $15,000

Depreciation expense 15,000

Accumulated depreciation 15,000

Disclosure is required describing the effect of the change in estimate on income before extraordinary items, net income and EPS.


c. On December 31, 2012, merchandise inventory was overstated by $25,000 due to a mistake in the physical inventory count using the periodic inventory system.

This is an accounting error that requires retrospective restatement.

2012: EI O/S COGS U/S NI O/S R/E O/S; also the asset inventory is overstated.

R/E 25,000


Inventory 25,000



d. The company changed inventory cost methods to FIFO from LIFO at the end of 2013 for both financial statement and income tax purposes. The change will cause a $960,000 increase in the beginning inventory at January 1, 2014.

This is a change in accounting principle that is reported retrospectively.

2013: EI U/S COGS O/S NI U/S R/E U/S; also, the asset inventory is understated.

Inventory 960 000


Inventory 960,000

Retained earnings 960,000

Prior years’ financial statements would be restated to reflect the use of the new accounting method. A disclosure note justifying the change and describing the effect of the change on any financial statement line items and EPS for all periods reported is required.


e. At the end of 2012, the company failed to accrue $15,500 of sales commissions earned by employees during 2012. The expense was recorded when the commissions were paid in early 2013.

This is an accounting error that requires retrospective restatement.

2012: Expense U/S NI O/S R/E O/S

2013: Expense O/S

R/E 15,500


Sales Commission Expense 15,500



f. At the beginning of 2011, the company purchased a machine at a cost of $720,000. Its useful life was estimated to be 10 years with no salvage value. The machine has been depreciated by the double-declining balance method. Its carrying amount on December 31, 2012 was $460,800. On January 1, 2013, the company changed to the straight-line method.

This is treated as a change in estimate that is handled prospectively.2013 Book value = $460,800R id l l $0


Residual value = $0Remaining life = 8 years (10 – 2)New depreciation = $460,800 ÷ 8 = $57,600Depreciation expense 57,600

Accumulated depreciation 57,600Previous financial statements are not restated. Rather, the company simply

utilizes the straight-line method from this point on.


g. Warranty expense is determined each year as 1% of sales. Actual payment experience of recent years indicates that 0.75% is a better indication of the actual cost. Management effects the change in 2013. Credit sales for 2013 are $4,000,000; in 2012, they were $3,700,000.

This is a change in estimate that is handled prospectively.

2013 Warranty expense = 0.75% x $4,000,000 = $30,000

Warranty expense 30,000

bl


Warranty payable 30,000

If the impact of the change in estimate is material, then a disclosure note should describe the effect of the change in estimate on income before extraordinary items, net income and EPS for the current period.

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Prob20_12